Investment Strategies for the Compliance Professional

Thomas Fox

Compliance Evangelist

Welcome to the final entry in our special five-part blog post series on how to unlock the gold in your program. I have visited with Gio Gallo and Nick Gallo, Co-CEO’s of ComplianceLine, LLC, the series sponsor. In this concluding Part 5, we consider investment strategies for the compliance professional.

We began with the basic concept in investing that the greater the risk, properly managed, the greater the potential return. From there, we turned to how would an investor type, whether it be a Private Equity (PE), Venture Capitalist (VC) or others, think through managing risk. What sort of models would they use? How could those models assist compliance professionals to manage risk? With proper risk management, this can create a huge return on your compliance investment.

Nick explained this is the relationship between risk and return and not the just existence of whether there is a risk at all. He stated, “The amount of risk that someone is willing to take on is generally tied to the return that they expect or the return that they think is possible.” For the compliance professionals this is “trying to give some new colors to paint with new words”. It allows you to speak finance language a little bit more. Finally, for someone with a legal training (like myself) he added, “even if you don’t actually understand all these concepts, at least appear to understand them, high enough level to be talking across the table.” It really boils down to a question of risk and return.

We considered the two big categories of investments in the alternative space (i.e., non-public and non-banking). The first is private equity investing and second is venture capital investing. A typical private equity investor is going to try to make a bunch of bets. They are going to try to have a positive return on virtually all of those bets, the standard deviation, the volatility or the range of outcomes are going to be particular and are going to be relatively more dialed in around what the upside is. This allows them to protect their downside by buying good businesses that are probably proven to some level. While there obviously is downside, hopefully there will be protection. Another way to look at is they are going to be running a bunch of different plays on those investments or on that portfolio so there is relatively a high confidence interval on a dialed in investment outcome with the possibility for some big pops.

On the other side of the fence, is venture capital investing, which tends to have a much wider standard deviation of return. Here investors take on companies at an earlier stage. Gio said, “Maybe they are not proven yet. Maybe they are not cashflow positive. Maybe they have not even found their legs or their market.” Here maybe one out of 10 investments pan out, although of course, if you hit big it can be a home run or even a grand slam.

Both of these examples are important because they demonstrate the lens through which a finance professional will look at a potential compliance program investment. There is actually a wide range of how a finance person is going to think about risk. It is not simply “is there a risk or not? Because the answer is there’s always risk.” Even if you can find the safest investment there is always some risk present.

The final concept to overlay on top of this is beta, which Nick explained “is essentially the extent to which a particular investment moves with the broader market. You can use this as a concept to talk about an investment in your ethics and compliance space, or we can boil it down to talk about the stability of an investment relative to the market. And some things will have a positive beta or a negative beta or a high beta or a low beta or whatever, but the market goes up 5% and your investment goes up 5% with it. The market goes down 5% and it goes down 5% with it has a beta of one. If the market goes up 5% and your investment goes up 10% and it goes down 5% and then the investment goes down 10%, it is more volatile and it’s swinging more violently with market moves and has a beta of, in this case, two.”

This allows a compliance profession to think about broad compliance investments in a similar framework. Your compliance investment may have “a beta of zero. This could generate positive returns for your bottom line, irrespective of what our business does. Whether our business is going up or it’s going down, these investments that we, as an ethics compliance department, want to make are going to reinforce our culture and you are going to drop dollars to our bottom line, irrespective of what’s happening with the top line.”

You can take that same concept further by positing a negative beta or a zero-beta investment. It is important to remember that when you speak to a finance professional you are “not just a risk person, you are speaking to a risk and return person.” This means they will understand that a compliance investment will perform particularly well in a down market. Nick concluded, “if you are making ethics and compliance investments or taking steps within your program or getting budget released to actualize your program, that actually releases the magic in the workforce by driving higher employee engagement and lowering turnover.” These are two areas that directly impact the bottom line regardless of what might be happening at the top line of the organization, “regardless of what headwinds the organization might be approaching or hitting.”

These concepts were all obviously new to me, but the Brothers Gallo are really on to something here. By using these approaches to talk to finance professional in their terms and approaching your budget from the finance perspective, you have a real opportunity to garner budget dollars to invest in your compliance program. By using the strategies of compounding and extending out the value of compliance throughout the organization, you can then demonstrate the return on that investment.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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